Performance fee

A performance fee is a fee that an investment fund may be charged by the investment manager that manages its assets, calculated by reference to the increase in the fund's net asset value (or "NAV"), which represents the value of the fund's investments. Performance fees are widely used by the investment managers of hedge funds, which typically charge a performance fee of 20% of the increase in the NAV of the fund.

Worked example

An example might be as follows:An investor subscribes for shares worth $1,000,000 in a hedge fund. Over the next year the NAV of the fund increases by 10%, making the investor's shares worth $1,100,000. Of the $100,000 increase, 20% (i.e. $20,000) will be paid to the investment manager, thereby reducing the NAV of the fund by that amount and leaving the investor with shares worth $1,080,000, giving a return of 8% before deduction of any other fees.

High water marks

The highest NAV of a fund to date is known as the "high water mark". If the NAV of a fund declines during a year, no performance fee will be payable to the investment manager. If the NAV subsequently increases over the following year back to the high water mark (but no higher), it would be objectionable for the investor to be charged a performance fee on that increase because the investor has not yet made any return on its investment. Therefore, to address this concern, hedge funds will typically only charge a performance fee on increases in NAV over the high water mark.

Hurdles

A hurdle, in the context of a performance fee, is a level of return that the fund must beat before it can charge a performance fee. It may be a set percentage or it may be referenced to an index. The index would typically be either LIBOR (or an equivalent) or an index reflecting the underlying market in which the fund is investing. The purpose of the latter is to reward the fund for generating returns that are better than the market (alpha) rather than for returns generated simply by movement in the market as a whole.

If, in the worked example, there had been a hurdle of 4%, the performance fee would only have been charged on the additional 6% increase rather than the full 10% increase in NAV.

As hurdles reduce the size of performance fees and reward successful active management, they are popular with investors. However, as demand for hedge funds has been high in recent years, fewer hedge funds have needed to resort to their use to attract investors.

Other fees

As well as a performance fee, a hedge fund will charge a management fee, typically calculated as 2% of the NAV of the fund, regardless of whether the fund has generated any returns for the investor. Hedge funds may also pay fees to administrators, prime brokers, lawyers, accountants and other service providers.

Terminology

While this article uses the term "NAV" for simplicity, in reality a performance fee would be charged by reference to the NAV "per share" (being the net asset value divided by the number of shares in issue). The NAV will fluctuate as investors subscribe for and redeem shares, whereas the NAV per share will only fluctuate as the underlying investments increase or decrease in value, making the latter the appropriate measure for calculating a performance fee.

Where a hedge fund is structured as a limited partnership or unit trust, the terms "interest" and "unit" should be substituted for "share" .


Wikimedia Foundation. 2010.

Look at other dictionaries:

  • Performance Fee — A payment made to a fund manager for generating positive returns. The performance fee is generally calculated as a percentage of investment profits, often both realized and unrealized. It is largely a feature of the hedge fund industry, where… …   Investment dictionary

  • performance fee — sėkmės mokestis statusas Aprobuotas sritis kolektyvinio investavimo subjektų veikla apibrėžtis Kintamas investicijų valdymo išlaidų dydis, priklausantis nuo valdomo investicinių priemonių portfelio vertės prieaugio. atitikmenys: angl. performance …   Lithuanian dictionary (lietuvių žodynas)

  • performance fee — /pəˈfɔməns fi/ (say puh fawmuhns fee) noun 1. the fee a performer, such as a concert pianist, opera singer, actor, etc., charges for a performance. 2. a fee paid to a staff member when they achieve a predetermined sales target. 3. a fee paid to… …   Australian English dictionary

  • fee — n [Middle English, fief, from Old French fé fief, ultimately from a Germanic word akin to Old High German fehu cattle] 1: an inheritable freehold estate in real property; esp: fee simple compare leasehold; life estate at estate …   Law dictionary

  • Fee-Only financial advisor — Fee Only financial advisors in the USA, as defined by the review materials for the Certified Financial Planner exam and the National Association of Personal Financial Advisors, are compensated solely by the client, typically achieved through a… …   Wikipedia

  • fee — A charge fixed by law for services of public officers or for use of a privilege under control of government. Fort Smith Gas Co. v. Wiseman, 189 Ark. 675, 74 S.W.2d 789, 790. A recompense for an official or professional service or a charge or… …   Black's law dictionary

  • Fee Structure — A chart or list showing the dollar amounts that a business charges for various services or activities. A fee structure lets customers or clients know what to expect when working with a particular business. Potential customers should always… …   Investment dictionary

  • Performance-based road asset management and maintenance contract — A Performance Based Road Asset Management and Maintenance Contract or PAMMC is one in which services are provided not on a unit basis (e.g. a fee per pothole filled in a road) but based on an agreed upon standards that the contractor is to… …   Wikipedia

  • performance for profit — The exclusive right of the proprietor of a copyright of a musical composition or his assignee. 18 Am J2d Copyr § 24. A performance for profit may exist, even though no admission fee is charged or no profit actually made. The performance of a… …   Ballentine's law dictionary

  • incentive fee — Compensation paid to commodities ( commodity) trading advisers or to any practitioner who achieves above average returns. Sometimes called performance fee. Bloomberg Financial Dictionary * * * incentive fee incentive fee ➔ fee * * * incentive fee …   Financial and business terms


Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”

We are using cookies for the best presentation of our site. Continuing to use this site, you agree with this.